Investment Income, Rentals, Capital Gains & You
Selling a house is an interesting and exciting time; in most cases, selling a home is something a person will only do a couple of times in their life, and will likely be overshadowed by the process of buying their next home, moving, and everything that goes with the entire process. For someone that is flipping or even renting houses as a primary income, however, the experience is much different – including, of course, the taxes owed.
Okay, great. You’ve decided to become a flipper, maybe you’ve even turned your first property. However, if you really want to make it in this business, there are a few things you should know about first, all of them have to do with how you handle your capital.
The Dreaded Income Tax
If you’re in the business of flipping houses and are even halfway successful, you’ll probably end up enjoying (we say that loosely) a higher tax bracket than you may be used to at your previous 9 to 5 jobs. The interesting thing about this tax is that it isn’t deducted from your paycheck every two weeks, only to be given back to you when you file your taxes in the form of an income tax return; no, that life is far behind you now. As a house flipper, you’ll have to claim and calculate your own income tax, and the sum will likely hit you like a punch in the gut. For a tax you likely failed to consider when you dreamed of flipping, you’ll be surprised to just how taxing it can be.
Hold On – Nobody Mentioned Income Tax
Wait a minute, you may be thinking, aren’t house sales exempt from income tax? Well, basically, no, they aren’t. Most home sales qualify for the 250/500 rule, which basically means that a single-person selling a home for less than 250,000 dollars enjoys no tax on the sale (500,000 for a married couple). However, the thing to understand here is that this rule assumes it is the family’s primary residence and the only home sale they will undertake in a given year. Obviously, neither of these are true for flippers. Perhaps capital gains tax is inevitable, after all that is what the 250/500 rule seeks to avoid right? All you should have to pay is a super low tax based on the difference of what you made in profit over what you paid in purchase price and material investment. Well, wrong again; the IRS considers short-term home flipping for profit as a business that grants income, giving you the luxury of paying much more in taxes. Lucky you.
The Term Struggle
Now, it is possible to avoid paying upwards of 30% of your profits (profits = income) in taxes, but the process to do so can and should turn you off of that idea. While you could pay a good amount less (maybe even half) by letting the property sit as a rental for upwards of a year or even simply holding onto it to claim the property as a long-term investment, therefore categorizing it as an investment, not an income-based good. The problem with this modality is time. Not only is your flip worth less and tougher to sell after it’s been lived in (or left empty) for a year, but you’ll be footing the bill for that property while you wait for it to mature into an investment; additionally, all tenant issues will be yours to deal with as well. Now, if you want to be a landlord and gradually acquire and sell rentals, there’s nothing wrong with that, but if you want to be a flipper, then you should ignore the notion of holding onto a property beyond six months.
The Golden Rule
Think about it, the entire time your investment is waiting to be sold, your money for the next flip is tied up inside. No, in these instances, even if it means paying an extra couple thousand in taxes for each house sold, it is important to follow the golden rule of flipping: Get in, get out, get another. Win, lose, or draw, your capital needs to shift from one flip to another in order for your business to stay profitable and for you to stay away from getting income tax taken out of a bi-weekly paycheck. By using the golden rule, you can take advantage of investment property loans to get you cash to buy and renovate numerous projects at once, allowing the 300,000 you’d have tied up in one house to become 50,000 tied up in 6 houses, which becomes 6 times the profit in the same amount of time. Just remember, unless you plan on burning all of your bridges with our private investors, it is important that you get in, get out, and get another.
Our Private Investors
If you’re hoping to walk in and out of a bank with the funds you’ll need for your flipping dreams, you’re going to be disappointed; not only do banks tend to dislike the risk/reward of flippers, but they struggle to approve the loan quick enough to get you the capital you need when you need it. Private Lending Group was formed to connect private investors with those looking to invest in property in the Greater Chicago Area, including you.